Risk Management Pre-Test Questions
Course Introduction
Risk Management is a comprehensive study of the identification, assessment, and prioritization of risks in various organizational and business contexts. The course covers techniques and tools used to manage and mitigate risks, including qualitative and quantitative analysis, and risk response planning. Students will explore the principles of risk assessment, the development of risk management plans, and the implementation of risk controls. Real-world case studies provide insights into the practical application of risk management strategies in fields such as finance, healthcare, engineering, and project management, emphasizing the importance of proactive decision-making and contingency planning.
Recommended Textbook
Fundamentals of Futures and Options Markets 9th Edition by John C. Hull
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Chapter 1: Introduction
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Q1) The price of a stock on February 1 is $124. A trader sells 200 put options on the stock with a strike price of $120 when the option price is $5. The options are exercised when the stock price is $110. The trader's net profit or loss is
A) Gain of $1,000
B) Loss of $2,000
C) Loss of $2,800
D) Loss of $1,000
Answer: D
Q2) A one-year call option on a stock with a strike price of $30 costs $3; a one-year put option on the stock with a strike price of $30 costs $4. Suppose that a trader buys two call options and one put option. The breakeven stock price above which the trader makes a profit is
A) $35
B) $40
C) $30
D) $36
Answer: A
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Chapter 2: Futures Markets and Central Counterparties
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Q1) Which entity in the United States takes primary responsibility for regulating futures market?
A) Federal Reserve Board
B) Commodities Futures Trading Commission (CFTC)
C) Security and Exchange Commission (SEC)
D) US Treasury
Answer: B
Q2) A company enters into a short futures contract to sell 50,000 units of a commodity for 70 cents per unit. The initial margin is $4,000 and the maintenance margin is $3,000. What is the futures price per unit above which there will be a margin call?
A) 78 cents
B) 76 cents
C) 74 cents
D) 72 cents
Answer: D
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Chapter 3: Hedging Strategies Using Futures
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Q1) On March 1 the price of a commodity is $1,000 and the December futures price is $1,015. On November 1 the price is $980 and the December futures price is $981. A producer of the commodity entered into a December futures contracts on March 1 to hedge the sale of the commodity on November 1. It closed out its position on November 1. What is the effective price (after taking account of hedging) received by the company for the commodity?
A) $1,016
B) $1,001
C) $981
D) $1,014
Answer: D
Q2) Which of the following does NOT describe beta?
A) A measure of the sensitivity of the return on an asset to the return on an index
B) The slope of the best fit line when the return on an asset is regressed against the return on the market
C) The hedge ratio necessary to remove market risk from a portfolio
D) Measures correlation between futures prices and spot prices
Answer: D
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Chapter 4: Interest Rates
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Sample Questions
Q1) At what interest rate does a government borrow in its own currency?
A) Treasury rate
B) LIBOR
C) LIBID
D) Repo rate
Q2) Prior to the credit crisis that started in 2007 which of the following was the proxy used by derivatives traders for the risk-free rate
A) The Treasury rate
B) The LIBOR rate
C) The repo rate
D) The overnight indexed swap rate
Q3) The two-year zero rate is 6% and the three year zero rate is 6.5%. What is the forward rate for the third year? All rates are continuously compounded.
A) 6.75%
B) 7.0%
C) 7.25%
D) 7.5%
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Chapter 5: Determination of Forward and Futures Prices
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Q1) Which of the following is NOT true about forward and futures contracts?
A) Forward contracts are more liquid than futures contracts
B) The futures contracts are traded on exchanges while forward contracts are traded in the over-the-counter market
C) In theory forward prices and futures prices are equal when there is no uncertainty about future interest rates
D) Taxes and transaction costs can lead to forward and futures prices being different
Q2) Which of the following is true for a consumption commodity?
A) There is no limit to how high or low the futures price can be, except that the futures price cannot be negative
B) There is a lower limit to the futures price but no upper limit
C) There is an upper limit to the futures price but no lower limit, except that the futures price cannot be negative
D) The futures price can be determined with reasonable accuracy from the spot price and interest rates
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Chapter 6: Interest Rate Futures
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Q1) Which of the following is NOT true about duration?
A) It equals the years-to-maturity for a zero coupon bond
B) It equals the weighted average of payment times for a bond, where weights are proportional to the present value of payments
C) Equals the weighted average of individual bond durations for a portfolio, where weights are proportional to the present value of bond prices
D) The prices of two bonds with the same duration change by the same percentage amount when interest rate move up by 100 basis points
Q2) A company invests $1,000 in a five-year zero-coupon bond and $4,000 in a ten-year zero-coupon bond. What is the duration of the portfolio?
A) 6 years
B) 7 years
C) 8 years
D) 9 years
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Chapter 7: Swaps
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Q1) A floating-for-fixed currency swap is equivalent to
A) Two interest rate swaps, one in each currency
B) A fixed-for-fixed currency swap and one interest rate swap
C) A fixed-for-fixed currency swap and two interest rate swaps, one in each currency
D) None of the above
Q2) Since the 2008 credit crisis
A) LIBOR has replaced OIS as the discount rate for non-collateralized swaps
B) OIS has replaced LIBOR as the discount rate, but only for non-collateralized swaps
C) LIBOR has replaced OIS as the discount rate for collateralized swaps
D) OIS has replaced LIBOR as the discount rate for swaps
Q3) Which of the following is usually true
A) OIS rates are less than the corresponding LIBOR rates
B) OIS rates are greater than corresponding LIBOR rates
C) OIS rates are sometimes greater and sometimes less than LIBOR rates
D) OIS rates are equivalent to one-day LIBOR rates
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Chapter 8: Securitization and the Credit Crisis of 2007
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Sample Questions
Q1) Which of the following tends to lead to an increase in house prices?
A) An increase in interest rates
B) Regulators specifying a maximum level for the loan-to-value ratio on mortgages
C) Banks reducing the minimum FICO score that borrowers are required to have
D) An increase in foreclosures
Q2) Suppose that ABSs are created from portfolios of subprime mortgages with the following allocation of the principal to tranches: senior 85%, mezzanine 10%, and equity 5%. (The portfolios of subprime mortgages have the same default rates.) An ABS CDO is then created from the mezzanine tranches with the same allocation of principal. How high can losses on the mortgages be before the mezzanine tranche of the ABD CDO bears losses?
A) 5.0%
B) 5.5%
C) 6.0%
D) 6.5%
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Chapter 9: Mechanics of Options Markets
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Q1) Consider a put option and a call option with the same strike price and time to maturity. Which of the following is true?
A) It is possible for both options to be in the money
B) It is possible for both options to be out of the money
C) One of the options must be in the money
D) One of the options must be either in the money or at the money
Q2) An investor has exchange-traded put options to sell 100 shares for $20. There is a 2 for 1 stock split. Which of the following is the position of the investor after the stock split?
A) Put options to sell 100 shares for $20
B) Put options to sell 100 shares for $10
C) Put options to sell 200 shares for $10
D) Put options to sell 200 shares for $20
Q3) An investor has exchange-traded put options to sell 100 shares for $20. There is a $1 cash dividend. Which of the following is then the position of the investor?
A) The investor has put options to sell 100 shares for $20
B) The investor has put options to sell 100 shares for $19
C) The investor has put options to sell 105 shares for $19
D) The investor has put options to sell 105 shares for $19.05
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Chapter 10: Properties of Stock Options
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Q1) When dividends increases with all else remaining the same, which of the following is true?
A) Both calls and puts increase in value
B) Both calls and puts decrease in value
C) Calls increase in value while puts decrease in value
D) Puts increase in value while calls decrease in value
Q2) Which of the following is the put-call parity result for a non-dividend-paying stock?
A) The European put price plus the European call price must equal the stock price plus the present value of the strike price
B) The European put price plus the present value of the strike price must equal the European call price plus the stock price
C) The European put price plus the stock price must equal the European call price plus the strike price
D) The European put price plus the stock price must equal the European call price plus the present value of the strike price
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Chapter 11: Trading Strategies Involving Options
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Q1) What is the number of different option series used in creating a butterfly spread?
A) 1
B) 2
C) 3
D) 4
Q2) How can a strap trading strategy be created?
A) Buy one call and one put with the same strike price and same expiration date
B) Buy one call and one put with different strike prices and same expiration date
C) Buy one call and two puts with the same strike price and expiration date
D) Buy two calls and one put with the same strike price and expiration date
Q3) Which of the following describes a protective put?
A) A long put option on a stock plus a long position in the stock
B) A long put option on a stock plus a short position in the stock
C) A short put option on a stock plus a short call option on the stock
D) A short put option on a stock plus a long position in the stock
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Chapter 12: Introduction to Binomial Trees
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Q1) The current price of a non-dividend-paying stock is $30. Over the next six months it is expected to rise to $36 or fall to $26. Assume the risk-free rate is zero. An investor sells call options with a strike price of $32. What is the value of each call option?
A) $1.6
B) $2.0
C) $2.4
D) $3.0
Q2) The current price of a non-dividend-paying stock is $40. Over the next year it is expected to rise to $42 or fall to $37. An investor buys put options with a strike price of $41. Which of the following is necessary to hedge the position?
A) Buy 0.2 shares for each option purchased
B) Sell 0.2 shares for each option purchased
C) Buy 0.8 shares for each option purchased
D) Sell 0.8 shares for each option purchased
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Chapter 13: Valuing Stock Options: the Bsm Model
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Q1) The volatility of a stock is 18% per year. What is the volatility per month?
A) 1.5%
B) 3.0%
C) 5.2%
D) None of the above
Q2) What does N(x) denote?
A) The area under a normal distribution from zero to x
B) The area under a normal distribution up to x
C) The area under a normal distribution beyond x
D) The area under the normal distribution between -x and x
Q3) What was the original Black-Scholes-Merton model designed to value?
A) A European option on a stock providing no dividends
B) A European or American option on a stock providing no dividends
C) A European option on any stock
D) A European or American option on any stock
Q4) Which of the following is assumed by the Black-Scholes-Merton model?
A) The return from the stock in a short period of time is lognormal
B) The stock price at a future time is lognormal
C) The stock price at a future time is normal
D) None of the above
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Chapter 14: Employee Stock Options
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Q1) Which of the following defines the vesting period?
A) The period during which employee stock options can be exercised
B) The period during which the options are issued
C) The period during which the strike price of the options equals the stock price
D) The period during which employee stock options cannot be exercised
Q2) Which of the following increases the expected life of employee stock options?
A) An increase in the vesting period
B) An increase in employee turnover
C) A fast growth rate for the stock price
D) A tendency for employees to exercise earlier than in the past
Q3) Which of the following is NOT usually true about employee stock options?
A) There is a vesting period
B) They can be sold to other employees
C) They are often at-the-money when issued
D) Their value is currently a charge to the income statement
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Chapter 15: Options on Stock Indices and Currencies
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Q1) What is the size of one option contract on the S&P 500?
A) 250 times the index
B) 100 times the index
C) 50 times the index
D) 25 times the index
Q2) For a European call option on a currency, the exchange rate is 1.0000, the strike price is 0.9100, the time to maturity is one year, the domestic risk-free rate is 5% per annum, and the foreign risk-free rate is 3% per annum. How low can the option price be without there being an arbitrage opportunity?
A) 0.1048
B) 0.0900
C) 0.1344
D) 0.1211
Q3) The domestic risk-free rate is 3%. The foreign risk-free rate is 5%. What is the risk-neutral growth rate of the exchange rate?
A) +2%
B) -2%
C) +5%
D) +3%
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Chapter 16: Futures Options and Blacks Model
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Q1) A futures price is currently 40 cents. It is expected to move up to 44 cents or down to 34 cents in the next six months. The risk-free interest rate is 6%. What is the value of a six-month put option with a strike price of 37 cents?
A) 3.00 cents
B) 2.91 cents
C) 1.16 cents
D) 1.20 cents
Q2) Which of the following is acquired (in addition to a cash payoff) when the holder of a call futures exercises?
A) A long position in a futures contract
B) A short position in a futures contract
C) A long position in the underlying asset
D) A short position in the underlying asset
Q3) Which of the following is NOT true?
A) Black's model can be used to value an American-style option on futures
B) Black's model can be used to value a European-style option on futures
C) Black's model can be used to value a European-style option on spot
D) Black's model is widely used by practitioners
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Chapter 17: The Greek Letters
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Q1) The delta of a call option on a non-dividend-paying stock is 0.4. What is the delta of the corresponding put option?
A) -0.4
B) 0.4
C) -0.6
D) 0.6
Q2) A trader uses a stop-loss strategy to hedge a short position in a three-month call option with a strike price of 0.7000 on an exchange rate. The current exchange rate is 0.6950 and value of the option is 0.1. The trader covers the option when the exchange rate reaches 0.7005 and uncovers (i.e., assumes a naked position) if the exchange rate falls to 0.6995. Which of the following is NOT true?
A) The exchange rate trading might cost nothing so that the trader gains 0.1 for each option sold
B) The exchange rate trading might cost considerably more than 0.1 for each option sold so that the trader loses money
C) The present value of the gain or loss from the exchange rate trading should be about 0.1 on average for each option sold
D) The hedge works reasonably well
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Chapter 18: Binomial Trees in Practice
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Q1) When we move from assuming no dividends to assuming a constant dividend yield, which of the following is true for a Cox, Ross, Rubinstein tree?
A) The parameters u and p change
B) p changes but u does not
C) u changes but p does not
D) Neither p nor u changes
Q2) Which of the following describes the way that the parameters in a binomial tree are chosen?
A) The expected return during each time step is the risk-free rate
B) The standard deviation of the return in each time step is, for small time steps, almost exactly equal to the volatility per annum times the square root of the length on the time step in years
C) The tree recombines
D) All of the above
Q3) Which of the following cannot be estimated from a single binomial tree?
A) delta
B) gamma
C) theta
D) vega
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Chapter 19: Volatility Smiles
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Q1) If the volatility implied from an at-the-money put currency option were used to price other put options on the currency, which of the following would be true?
A) Out-of-the money and in-the-money prices would be too high
B) Out-of-the money and in-the-money prices would be too low
C) Out-of-the-money option prices would be too high and in-the-money option prices would be too low
D) Out-of-the-money option prices would be too low and in-the-money option prices would be too high
Q2) A volatility surface is a table showing the relationship between which of the following
A) Implied volatility, time to maturity, and strike price
B) Implied volatility, historical volatility, and time to maturity
C) Historical volatility, strike price, and time to maturity
D) None of the above
Q3) Which of the following could be a result of "crashophobia"?
A) High volatilities for in-the-money calls
B) High volatilities for in-the-money puts
C) High volatilities for at-the-money calls
D) Low volatilities for at-the-money puts
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Chapter 20: Value at Risk and Expected Shortfall
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Q1) Which of the following is true of the historical simulation method for calculating VaR?
A) It fits historical data on the behavior of variables to a normal distribution
B) It fits historical data on the behavior of variables to a lognormal distribution
C) It assumes that what will happen in the future is a random sample from what has happened in the past
D) It uses Monte Carlo simulation to create random future scenarios
Q2) Which of the following is true?
A) Cash flow mapping is a way of calculating the present value of cash flows
B) Cash flow mapping is used to handle interest rate exposures in the model building approach
C) Cash flow mapping is used to handle interest rate exposures in the historical simulation approach
D) None of the above
Q3) What does EWMA stand for?
A) Equally weighted moving average
B) Equally weighted median approximation
C) Exponentially weighted moving average
D) Exponentially weighted median average
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Chapter 21: Interest Rate Options
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Q1) Which of the following is assumed to be lognormal when a caplet is valued?
A) A future bond price
B) A future swap rate
C) A future short-term rate
D) A future long-term rate
Q2) A Eurodollar futures option contract has a strike price of 97 and the Eurodollar interest rate is 2.50%. What is the intrinsic value of the contract if the option is a put?
A) $0
B) $1,250
C) $1,750
D) $2,500
Q3) The price of a December put futures option is quoted as 5-52. Each Treasury bond futures contract is for delivery of $100,000 in Treasury bonds. What is the cost of one contract?
A) $5,520.00
B) $5,812.50
C) $6,625.00
D) $8,250.00
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Chapter 22: Exotic Options and Other Nonstandard Products
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Q1) In a shout call option the strike price is $30. The holder shouts when the asset price is $40. What is the payoff from the option if the final asset price is $35?
A) $0
B) $5
C) $10
D) $15
Q2) When can Bermudan options be exercised?
A) Any time during the life of the options
B) Any time after a certain date up to the end of the life of the life
C) Any time before a certain date or at the end of the option's life
D) On dates specified at the start of the option
Q3) A binary option pays of $100 if a stock price is greater than its current value in three months. The risk-free rate is 3% and the volatility is 40%. Which of the following is its value?
A) 99.25N(-0.1375)
B) 99.25N(0.1375)
C) 99.25N(-0.0625)
D) 99.25N(0.0625)
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Chapter 23: Credit Derivatives
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Q1) A CDS with a number of reference entities provides a payoff when any of the reference entities defaults. What is a name for this CDS?
A) Binary CDS
B) Add-up Basket CDS
C) First-to-Default CDS
D) n-to-Default CDS
Q2) Which of the following is the most popular life for a credit default swap?
A) 1 year
B) 3 years
C) 5 years
D) 10 years
Q3) What is the number of companies underlying the CDX NA IG index?
A) 50
B) 75
C) 100
D) 125
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Chapter 24: Weather, Energy, and Insurance Derivatives
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Q1) Which of the following describes a CAT bond?
A) Has a great deal of systematic risk
B) Has very little systematic risk
C) Has a moderate amount of systematic risk
D) Has negative systematic risk
Q2) Where are oil, gas, and electricity derivatives traded?
A) On exchanges and the OTC market
B) On exchanges, but not on the OTC market
C) On the OTC market , but not on exchanges
D) Oil is traded in both markets, but the other two are traded only in the OTC market
Q3) An August CDD weather option is offered on the cumulative monthly CDD at an Atlanta weather station. An investor has a long call with a strike price of 375 and a short call with a strike price of 400. The payment is $10,000 per degree day. What is the maximum payoff?
A) $500,000
B) $250,000
C) $100,000
D) $50,000
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